Corporate Governance and stock market liquidity in India

By
P.Krishna Prasanna, Assistant Professor, IIT Madras, India

Anish S Menon, Research Scholar, IITM

Abstract

Corporate Governance encompasses processes for board effectiveness and enhanced transparent
disclosures. Both these requirements result in improved quality and quantity of information made
available to investors. This information flow is expected to result in informed trading, reduce
information asymmetry and improve market liquidity.

We examine the relationship between the firm level corporate governance and stock liquidity in
Indian market. We constructed corporate governance index through content analysis of corporate
governance reports published annually as a part of annual report of the Indian listed companies. We
used Illiquidity Ratio suggested by Amihud(2002) and its modified form used by Bortolotti et al.
(2007)to measure the stock liquidity. We empirically observe that corporate governance had a
positive impact on stock liquidity. Better governed companies had higher liquidity. This is positive
finding for the cross section of governance players (both for policy makers as well as the listed
companies) that a decade of governance reforms provides benefit for the firms‟ adhering good
governance practices. Our results are in support of arguments made by Welker (1995) and Chung
(2010). We also examine the relationship between the ownership pattern and the stock liquidity. We
found that higher promoter holdings reduce stock liquidity. We strengthen the belief that foreign
institutional investors and their investments provide liquidity to emerging stock markets like India.
 Corporate Governance and stock market liquidity in India

I. Introduction

Effective corporate governance helps to build vibrant and efficient capital markets. Investor‟s
confidence will be more in the markets where companies have high standards of corporate
governance. Ronald J. Gilson (2000) stated that equity investment requires good corporate
governance and good corporate governance requires credible corporate disclosures.

Corporate Governance encompasses processes for board effectiveness and enhanced transparent
disclosures. Both these requirements result in improved quality and quantity of information made
available to investors. There is evidence in the recent governance literature that this information flow
influences stock markets and results in informed trading, reduces information asymmetry and
improves market liquidity.

The empirical research from the developed markets prescribe that both internal and external corporate
governance mechanisms improve stock market liquidity (Bacidore and Sofianos, 2002). Jain et.al
(2008) found that Sarbanes Oxley Act, 2002 had highly significant and positive long term liquidity
effects .They asserted that these improvements were positively associated with improved quality of
financial reports.

In India the concept of corporate governance is just a decade old. Actively traded stocks are few and
market driven capital markets are just evolving. More over issues of corporate governance are
different as most successful companies are family run firms with concentration of ownership. Given
this background Research Questions that arises are:

 Do better governed companies contribute to efficient stock market behavior?

 Do the additional disclosures result in informed trading or add to extra cost of compliance to the
companies?
 How does firm level corporate governance impact the liquidity of its stock?
The present study examines the impact of firm level governance quality upon the liquidity of the
stock in the market.

The results of our study contribute to the existing limited literature on stock market liquidity in India.
The paper provides new evidence on relationship of market liquidity and corporate governance
mechanism in India. Our results also contribute to the ongoing debate on costs and benefits of
governance reforms.

The remaining sections of the paper are organized as follows: Section 2 presents review of literature
and research hypotheses. Section 3 describes the data and sample selection. Section 4 presents
empirical results and Section 5 concluding remarks.

2. Review of Literature and Research Hypothesis

A key aspect of information disclosure relates to a firm‟s governance. Many research studies
established that information flow and stock market liquidity are closely associated.

2.1 Corporate governance, Disclosure quality, asymmetric information and stock market
liquidity

Fundamental relationship between information and stock price behavior is established by

Grossman, and Stiglitz (1980). They explained that improving cost-benefit trade-off on
information collection leads to more informed trading and more informative pricing. Gompers
et.al.(2003) find that governance can directly influence stock prices. The effect on stock returns
and prices requires link between governance provisions, disclosure requirements and information
to investors. Shen and Lin (2010) observed that in case of better governed companies the
relationship between fundamental signals and stock returns is strong.

Welker (1995) elaborated the relation between disclosure policy and its influence on market
liquidity. Disclosure policy influences stock markets because uninformed investors “Price
protect” against adverse selection and this price protection is manifested in market liquidity.
They found that well regarded disclosure policy reduces information asymmetry and hence
increases liquidity in equity markets.

Brown (2007) narrate that disclosure quality results in less trading by privately informed traders
and reduce Information asymmetry. They found negative relation between the information
asymmetry and disclosure quality of annual reports and investor relations activity. The quality of
quarterly reports disclosure is found to be positively associated with Information asymmetry.

Cai et.al. 2009 observed the impact of asymmetric information on three mechanisms of corporate
governance: The intensity of board monitoring, exposure to market discipline and the pay for
performance sensitivity of CEO compensation. They found firms facing greater asymmetric
information tend to use less intensive board monitoring but rely more on market discipline and
CEO incentive compensation. They suggested that regulators should use caution when imposing
uniform requirements on firm‟s corporate governance.

Chen et.al. (2007) argues that the companies adopting poor information transparency and
disclosure practices will experience serious information asymmetry. They empirically observed
that costs of liquidity are greater for the companies with poor information transparency and
disclosure practices.

Miguel and Paul (2007) reported that better corporate governance, openness to market for
corporate control leads to more informative stock prices by encouraging collection of and trading
on private information. They assert that information flow interpretation implies that the
component of volatility is related to governance.

Dennis Cormier et.al. (2010) investigated the impact of governance on information asymmetry
between managers and investors. They narrated how a firm‟s governance maps in to the level of
information asymmetry between the managers and investors. They found that governance
disclosures reduce information asymmetry.

Kanagaretnam et.al(2007) found that firms with higher levels of corporate governance have
lower information asymmetry around quarterly earnings announcements. Chung et.al.(2010)
found that firms with better corporate governance have narrower spreads, higher market quality
index, smaller price impact of trade and lower probability of information based trading. Given
these results they suggested that firms may alleviate information based trading and improve
stock market liquidity by adopting corporate governance standards that mitigate informational
asymmetries.

Hypothesis 1

Ideally corporate governance through tougher disclosure regulation should contribute to less
fluctuation in stock prices. Indian companies are now transparent not on their own choice but there
have been structures in place that facilitate the market participants to gather information which gets
reflected on prices. This information should facilitate quality of price formation and should ideally
result in improving the liquidity in the capital markets.

Board effectiveness Results in improved

CORPORATE
DEMANDS quantity and quality
GOVERNANCE
of information
Disclosure requirements disclosures to traders

Improves liquidity
Reduces
information
asymmetry

Reduces volatility

H1: Companies with higher level of corporate governance will experience reduction in
information asymmetry and improved stock market liquidity.

2.2 Corporate Governance, Firm ownership and stock Liquidity

 Corporate Governance advocates believe that ownership dispersion is desirable and it would provide
market liquidity. It is believed that ownership concentration results in limited information made
available to the investors in the capital markets. Lack of information will make investors to consider
the firms as high risk entities. Retail investors will no longer be willing to provide funds which will
result in illiquid stock markets. Gaspar and Massa (2007) investigated how ownership patterns affect
the liquidity of its stock. They found that informed ownership improves governance and induces
value enhancing decisions. Becht (1999) counter argues that ownership dispersion will de-motivate
the individual investors to exercise proper controls on the management which will have negative
effect on stock liquidity. Rhee &Wang (2009) examined Granger causality between foreign
institutional ownership and Stock market liquidity. They found that foreign holdings have negative
impact on future liquidity. Their observation challenges the view that foreign institutional ownership
enhances liquidity in small emerging markets. Thus there are arguments in all the directions in the
literature throwing open the following research questions:

 Does the ownership dispersion affect the stock liquidity in a positive direction?
 What is the impact of the block of shares cornered by the promoter‟s group on liquidity?
 Do the companies with higher foreign institutional investments (FII) experience higher liquidity?

Our paper examines the following hypothesis;

H2 a: Higher FII investments result in higher liquidity

H2 b: Higher promoter holding will have negative impact on the liquidity

3. Sample selection, data and Variable definitions

Our sample consists of all the firms included in BSE 100 Index which represent actively traded
stocks in Indian capital market. The BSE-100 Index is a broad-based index launched in 1989 and has
1983-84 as the base year. The Index is well diversified with companies representing 43 industries.
(List given in Annexure: 3)

There are around 4990 listed companies in Bombay stock exchange. The total market capitalization
of all these companies is Rs. 6963116.67 crores as on Dec22nd, 2010. (Source: CMIE data base) The
top 100 liquid companies are included in BSE 100 Index. The market capitalization of all BSE 100
index (our sample) companies put together is 4755169.98 Crores (as on Dec22nd, 2010) which
68.29% of the total market capitalization. This shows that the sample adequately include all the
actively traded stocks and covers around 70% of the population. The data-set consists of the cross-
sectional annual data for the 90 companies for the financial year 2009-2010.

We collected the data of the closing price, daily market capitalization (in rupees) and daily turnover
(in rupees). This was collected from the official website of the BSE. The data file contained the date,
open price, Close price, high price, low price, weighted average price, number of shares traded,
number of trades, total turnover in rupees, spread high-low and spread open-close.

We collected the detailed ownership pattern of the companies as on 31st March, 2010. This data was
collected from the „Prowess‟ database of the Centre for Monitoring Indian Economy (CMIE).The
data on governance variables was collected from Corporate Governance reports of the sample
companies. The financial data regarding the sample firms was collected from Capital line database.

3.2 Empirical measures of Firm level Corporate Governance

Quality of firm level Governance will be measured and quantified using variables in the previous
research studies (Jiraporn & Ning, 2006) and Officer (2006). The effectiveness of firm level
governance mechanism is assessed through the four major parameters Independence of the board
(composition), managerial compensation, ownership stake of promoter directors and board committee
effectiveness.

This paper uses firm level governance variables to measure the quality of corporate governance of
sample companies. We use variables that have been considered as indicators of good governance to
construct the index of firm level corporate governance. The variables include the % of independent
directors in board composition, their participation in board meetings, governance committee
meetings, Director‟s presence in Annual General Meeting, duality of chairman and CEO etc.(Details
of Governance Index provided in Annexture1) The variables are rated on a slab system with higher
score indicating better governance quality.

3.3. Empirical measures of stock Liquidity

Empirical market microstructure literature suggests alternative ways to measure Stock market
liquidity. Chordia and Subrahmanyam (1998) used trading volume to measure liquidity while
Datar, Naik and Radcliffe (1998) used turnover. Another widely used measure in recent studies
is the “Amivest” liquidity which is defined as the average of daily ratio of volume to absolute
return (Chan et al,, 2005). This ratio is proxy for market depth. Amihud (2002) demonstrated that
inverse of this ratio referred as Illiquidity Ratio can be used to measure the price impact.

Many of the research studies referred in previous section used bid-ask spread as a measure of
liquidity (Kanagaretnam, 2007, Chung, 2010, Chen et.al. 2007, Welker, 1995). In an order
driven market (like India) lack of transaction data do not provide information for measuring bid-
ask spread. Hence we use the „Illiquidity Ratio‟ as proposed by Amihud (2002) and its modified
version as proposed by Bortolotti et al. (2007) to measure the stock liquidity.

The stock illiquidity is defined as the average ratio of the daily absolute returns to the (rupee)
trading volume of the day. It is the ratio of the return per day to the daily traded volume in
rupees. This value is then averaged across the number of trading days in a year to get proxy for
stock liquidity. Amihud (2002) says that the ratio is closely related to the Amivest ratio and also
follows the Kyle‟s concept of illiquidity which is the response of price to order flow (Kyle
1985). Marcelo and Quiros, (2006) commented that the Illiquidity Ratio has a strong theoretical
appeal and considers it the best proxy for illiquidity.

Daily return: R = (P1-P0)/P0

where R is the daily return, P1 is the current day‟s closing price and PO is the previous day‟s
closing price. The absolute values of these returns were taken to compute the following
Illiquidity Ratio:

Riyd is the return on stock i on day d of year y and VOLDiyd is the respective daily volume in rupees
Amihud (2002).

This value was then multiplied by 10 raised to the power of 8 to aid in computational convenience. This
was then averaged over the period of working days in the financial year

Another variant of the Amihud illiquidity has been formulated by Bortolotti et al. (2007). Here illiquidity
is computed as the ratio of the absolute return to turnover.

We also calculated the Bortolotti et al. (2007) version of the Amihud ratio (hereafter called the Modified
Amihud ratio).
ILLIQ = D-1

The Modified Amihud ratio was calculated as the ratio between the absolute daily return and the daily
turnover ratio as calculated above. Turnover in this case is equal to the total value of shares traded scaled
by total daily market capitalization. This was averaged over the period of the total working days in the
financial year.

A high value of this measure indicates that the market is illiquid because there is a considerable price
change in the stock in response to a comparatively small change in the turnover.

4. Empirical Analysis
4.1 Computed Governance Index of sample companies

In India Corporate Governance reforms began with the legislation of clause 49 of the Listing
Agreement enacted in 2000. Securities and Exchange Board of India (SEBI) has legislated the first
formal governance regulation by inserting clause 49 in the stock exchange listing agreement with an
intention of promoting and raising the corporate governance standards of Indian companies. The
regulation broadly deals with

Board structure and composition

Governance through board committees like audit committee, Remuneration committee and
Shareholders Grievance committee
Required additional disclosures to improve transparency

A series of changes in the regulations since 2000 have considerably altered the way Indian
companies are governed. There was a gradual change in the composition of Indian boards. Many
of the directors join the boards as non-executive directors who are expected to provide expert
guidance to the management and not participate in the management process. Similarly the
composition and participation of independent directors increased who are expected to contribute
maximization of share holder‟s value and offer investors protection. Table 1 presents the board
composition-related-statistics. 50% of the directors in the sample companies are independent as
required by the legislation. Their participation in the board room decisions primarily can be
gauged from their attendance in board meetings. On an average 76% of them attend the board
meetings. There is also a conscious split in the leadership of management and the board. Out of
the sample companies nearly 50% of companies had non-executive chairman. However 50% of
them are promoter non- executives.
 Table 1: Descriptive statistics – Board composition of sample companies
Independent
Independent Directors -
Percentage Directors - Percentage
Total No. of No. of No. of non of Percentage Attendance No. of
number executive non executive Independent Total no. Attendance in Annual No. of members
Descriptive of promoter executive Independent directors in board in Board General audit in Audit
statistics directors directors promoters directors Board meetings Meetings Meetings meetings committee
Mean 11 2 1 5 50 8 76 66 6 4
Median 11 1 0 5 50 7 78 67 5 4
Mode 11 0 0 4 50 5 60 100 4 4
Maximum 22 9 8 11 86 40 100 100 11 9
Minimum 5 0 0 2 13 3 0 0 1 3

Table 2: Chairmanship of Companies

Executive Directors 26
Executive Promoters 19
Non executive promoters 21
Non- executive and Independent directors 24
Total sample 90

Board effectiveness can also be assessed from the functioning of sub committees and their
reviews. All the sample companies had audit committees, shareholders grievance committees
and remuneration committees. The meeting schedules, agenda and participation have been
disclosed in their governance reports.

The reforms also resulted in a significant improvement in the disclosure practices of Indian
companies. The information relevant to important corporate actions is made available through
their web pages of investor relations. Further information about the board meetings, directors‟
profiles, chairman‟s speeches, CEO interviews & press meetings and analyst‟s reports are posted
on the companies‟ websites.

Taking the board composition, board quality and effectiveness and governance committee
functioning as the key parameters the corporate governance index has been constructed for each
sample company. The cumulative total of this index is referred as CG score and is used for
analyzing impact of corporate governance on the stock liquidity. Table 3 presents the descriptive
statistics and Annexure 1 provides the detailed scoring scheme.

Table:3 – Corporate Governance Score

Particulars Corporate Governance Score

Mean 24
Median 25
Mode 26
Minimum 16
Maximum 30
Count 90

4.2 Corporate Governance and Stock liquidity

We examine the relationship between firm level Corporate Governance and its stock liquidity.
The previous studies which examined this relationship have taken bid-ask spread to proxy the
liquidity affect of stock. We used (Amihud,2002) Illiquidity Ratio to measure stock liquidity.
Table 4 presents the bivariate relationship between computed CG score and the stock Illiquidity
Ratio. CG Score has statistically significant impact on both the Illiquidity Ratio and Modified
Amihud Ratio. The negative regression coefficients explain that higher the CG score, lower is
the Illiquidity Ratio implying higher CG score, higher the stock liquidity. These results are
consistent with our hypothesis that better governed companies will have higher stock liquidity
Total Remuneration paid to directors has been taken as another governance variable .The
remuneration include the salary paid to executive directors as well as the commission and sitting
fees paid to non- executive directors. This has a negative impact on stock liquidity. However it
was not found significant.
Table 4 : Corporate Governance and stock liquidity

R Square F Significance F Coefficients t Stat P-value

Illiquidity Ratio and
Corporate Governance
Index
Dependent variable - IR
Independent variable - CGI 0.042 3.7288 0.0568 -1.3849 -1.931 0.0568
Modified Amihud Ratio and
Corporate governance Index
Dependent variable - MAR
Independent variable - CGI 0.0469 4.1864 0.0438 -25.3777 -2.0461 0.0438**
 Dependent Variable – MAR
Independent Variable - TDR 0.0179 1.4199 0.2370 -1.91334 -1.9163 0.2370
CGI – Corporate Governance Index, MAR – Modified Amihud Ratio, IR – Illiquidity Ratio, TDR – Total
Remuneration paid to all the directors

To moderate the differences in the firm size total assets has been considered as controlling
variable. Table 5 report the interaction between the firm size and stock liquidity. Firm size had a
negative impact on Illiquidity Ratio indicating bigger the firm –higher the liquidity. The
modified ratio also had a negative impact; however it is not statistically significant. While
computing modified Amihus ratio the turnover is scaled to the size of market capitalization and
this turnover rate is taken as denominator. In this context the firm size gets moderated while
computing the modified Amihud ratio. Hence firm size did not show additional significant
impact on the stock liquidity.

Table 5 Firm Size and Stock Liquidity

R Square F Significance F Coefficients t Stat P-value

Illiquidity Ratio and
Total assets
Dependent Variable IR
Independent Variable -
TA 0.045 4.1487 0.0447** -0.0001 -2.0368 0.0447**

Modified Amihud
Ratio and Total assets
Dependent Variable -
MAR Independent
Variable - TA 0.0027 0.2367 0.6278 -0.0004 -0.4866 0.6278
MAR – Modified Amihud Ratio , IR – Illiquidity Ratio, TA – Total Assets

We report the results of multivariate tests incorporating the total assets to control firm size in
table 6. The impact of CG Score is still statistically significant confirming our Hypothesis 1.

Table 6: Impact of Corporate governance up on the stock liquidity controlling for firm size
Modified Amihud Ratio and Corporate governance Index controlling for firm size

R Square F Significance F Coefficients t Stat P-val P-value

CG 0.0477 2.105 0.1282 -24.9423 -1.9826 0.0507**

 TA -0.0003 -0.2636 0.7927

4.3 Ownership pattern and Stock Liquidity

Table 7 presents the descriptive statistics about the ownership pattern in the sample companies.
On an average 50% of the equity capital is owned by the promoters. Foreign Institutional
investors and retail public own 19% and 18% respectively. Domestic institutions own 13% on an
average in the sample companies. Further The Sample companies comprises of 4 types of
promoters. There are 4 types of promoters. In majority of sample companies (62) it was the
business families holding the major stake. There were 12 companies in which the Indian
Government was the promoter. There were 9 companies in which foreign body corporates were
shareholders. Categorical variable has been included to understand whether the difference make
any impact on stock liquidity.
Table:7 : Ownership Pattern Descriptive statistics
Foreign
Institutional
Investors
Promoters (%) - Non- Domestic Other
Particulars holding (%) Promoters Institutions Investors

Mean 50 18 13 19
Median 50 15 11 18
Minimum 0 0 1 0
Maximum 99 65 43 78
Count 90 90 90 90

7A .-Promoter categories
Government Joint
Family Holdings Foreign Ventures
Particulars Holdings (%) (%) Promoter (%) (%)

Mean 46 73 54 51
Median 46 76 53 53
Minimum 0 51 37 18
Maximum 90 99 68 80
Count 62 9 12 7
Categorical Variable Code Number of companies
 Table -7B

Type of promoter

Indian 1 62
Foreign 2 9
Government 3 12
Joint Venture 4 7
Total 90

Table 8 presents OLS (ordinary least square estimates) between the promoter holdings and the
Illiquidity Ratio. Higher the promoter holding higher is the Illiquidity Ratio interpreting lower
stock liquidity. However the impact is not statistically significant. Table 9 presents the OLS
results between the promoter holdings and modified Amihud ratio. The negative impact between
the promoter holdings and stock liquidity is statistically significant even after controlling for firm
size confirming our hypothesis 2a. Type of promoter had initially found to have a significant
impact, however when taken with other variables it was not significant.
Table 8: Promoters holdings and stock liquidity OLS estimates using Illiquidity Ratio
Illiquidity Ratio and
Promoter holdings
Significance
R Square F F Coefficients t Stat P-value
Total Promoter holding 0.0072 0.6338 0.4281 0.0787 0.7961 0.4281
Illiquidity Ratio and
Promoter holdings
Dependent Variable:
Illiquidity Ratio 0.0564 2.5994 0.0801**
Total assets -0.0001 -2.1306 0.0359**
Promoters holding
(Percentage) 0.0997 1.0236 0.3089
Modified Amihud Ratio
and Promoter Holdings
Dependent Variable:
Modified Amihud Ratio 0.0217 0.9644 0.3853
Total Promoter holding 0.0967 0.9681 0.3357
Type of promoter/
categorical variable -2.554 -1.1371 0.2586
Illiquidity Ratio and
Promoter holdings
Dependent Variable:
Illiquidity Ratio 0.0806 2.5132 0.0638**
Total assets -0.0001 -2.3475 0.0212**
 Promoters holding
(Percentage) 0.1255 1.2781 0.2047
Type of promoter/
categorical variable -3.3341 -1.5051 0.136

Table 9: Promoters holdings and stock liquidity OLS estimates using Modified Amihud Ratio
Modified Amihud Ratio
and Promotors holdings

R Square F Significance F Coefficients t Stat P-value

**
Total Promoter holding 0.158 16.5134 0.0001 6.413 4.0637 0.0001**
Modified Amihud Ratio
and Promotors holdings
Dependent Variable:
Modified Amihud Ratio 0.195 10.5343 0.0001**
Total Promoter holding 3.7751 1.8529 0.0673**
Type of promoter/
categorical variable 113.5425 1.9984 0.0488**
Modified Amihud Ratio
and Promotors holdings
Dependent Variable:
Modified Amihud Ratio 0.0564 2.5994 0.0801
Total assets -0.0001 -2.1306 0.0359**
Promoters holding
(Percentage) 0.0997 1.0236 0.3089
Modified Amihud Ratio
and Promotors holdings
Dependent Variable:
Modified Amihud Ratio 0.1758 6.1166 0.0008**
Total assets -0.0009 -1.0822 0.2822
Promoters holding
(Percentage) 6.8423 4.2437 0.0001**
Type of promoter/
categorical variable -35.7905 -0.9842 0.3278

Table 10 reports the regression results between the FII holdings and stock liquidity. Higher
investments from FII improve stock liquidity. This relationship ship was not found in the initial
Illiquidity Ratio. The FII investments had statistically significant negative impact up on the stock
modified Amihud ratio. This implies that higher FII investments contribute to increase stock
liquidity. This confirms our Hypothesis 2b.

Table 10 : FII Investments and Stock liquidity

Illiquidity Ratio and
Foreign Institutional
Investments(FII)

R Square F Significance F Coefficients t Stat P-value

0.0017 0.1525 0.6971 -0.0649 -0.3905 0.6971
Illiquidity Ratio and
Foreign Institutional
Investments( FII)
FII 0.0491 2.2458 0.1119 -0.1001 -0.6104 0.5432
TA -0.0001 -2.0817 0.0403

Modified Amihud Ratio

and Foreign Institutional
Investments( FII)
0.0814 7.8025 0.0064** -7.7231 -2.7933 0.0064**
Modified Amihud Ratio
and Foreign Institutional
Investments( FII)
FII 0.0881 4.2032 0.0181** -7.9522 -2.8549 0.0054**
TA -0.0007 -0.7976 0.4273
FII – Foreign Institutional Investors, TA – Total Assets

Table 11 presents the impact of investments made by domestic institutional investors up on the
stock liquidity. They had a negative impact that is not significant. Higher investments from
domestic institutions result in reducing Illiquidity Ratio and increase stock liquidity. The impact
retail investors had significantly negative impact on the up on the modified Amihud ratio. They
provide more liquidity to stock.

Table: 11-Domestic and Retail Investors and Stock Liquidity

 Illiquidity Ratio and
Domestic Institutional
Investments (DII)
R Significance
Square F F Coefficients t Stat P-value
0.0024 0.2116 0.6466 -0.1021 -0.46 0.6466
Modified Amihud Ratio
and Domestic Institutional
Investments
0.0271 2.4526 0.1209 -5.9524 -1.5661 0.1209
Modified Amihud Ratio
and other
investors(individuals)
0.0271 8.4594 0.0046** -9.1955 -2.9085 0.0046**
Modified Amihud Ratio :
DII and other
investors(individuals)
0.0954 4.5865 0.0128**
DII -3.2914 -0.8595 0.3924
Other Investors
Individuals -8.4288 -2.5623 0.0121**

Table 12 presents the correlation matrix between the different owners of equity capital.
Promoters holding had a significant negative relationship with all the other groups. Higher the
promoters holding-lower will be the contribution from the foreign institutional investors,
domestic institutional investors and the retail investors. Higher holding by promoters will result
in lower dispersion in ownership.
Table: 12-Correlations

PR FII DII OI
PR Pearson Correlation 1
Sig. (2-tailed)
N 90
FII Pearson Correlation -.638(**) 1
Sig. (2-tailed) .000
N 90 90
DII Pearson Correlation -.599(**) .020 1
Sig. (2-tailed) .000 .854
N 90 90 90
OI Pearson Correlation -.678(**) .063 .271(**) 1
Sig. (2-tailed) .000 .554 .010
N 90 90 90 90
** Correlation is significant at the 0.01 level (2-tailed).
Panel Data Results
A sub sample of 55 companies was consistently found part of BSE 100 index from the year
2007-2010. Ownership data was available quarterly for the sample companies. Panel data was
collected regarding ownership variables and illiquidity ratio was computed for 12 quarters from
2007-2010. There was not much variation in ownership data over the 12 quarters. Hence panel
data was analyzed with random effects regression. The results were not different from that cross
section analysis presented in the previous section.

Table 13 : Panel data regression (Random effects)

Dependent Variable Independent Variable Regression coefficient P Value
Amihud illiquidity Ratio Promoter‟ holding 0.1933 0.001**
Domestic Institutions share 0.905 0.001**
Modified illiquidity Ratio Promoter‟ holding 0.1292 0.001**

Domestic Institutions share 0.927 0.001**

No. of observations 660
No. of quarters 12
No. of Groups 55

The promoters holding as well as the shares cornered by domestic institutions were not traded
widely. Higher holding by these groups resulted in higher illiquidity ratio implying less stock
liquidity.
Table 14 : Panel data regression (Random effects)
Dependent Variable Independent Variable Regression coefficient P Value

Amihud illiquidity Ratio FII -0.227 0.923

Modified illiquidity Ratio FII -0.298 0.816

No. of observations 660

No. of quarters 12
 No. of Groups 55

Foreign institutional investment had negative impact on the illiquidity ratio. However this
relationship is not statistically significant. This implies higher foreign institutional investment
results in higher liquidity in the stock market.

5. Concluding Remarks

We examine the relationship between the firm level corporate governance and stock liquidity in
Indian market. We constructed corporate governance index through content analysis of corporate
governance reports published annually as a part of annual report of the Indian listed companies. We
used Illiquidity Ratio suggested by Amihud(2002) and its modified form used by Bortolotti et al.
(2007)to measure the stock liquidity. We empirically observe that corporate governance had a positive
impact on stock liquidity. Better governed companies had higher liquidity. This is positive finding for
the policy makers that a decade of governance reforms provides benefit for the firms‟ adhering good
governance practices. Our results are in support of arguments made by Welker (1995) and Chung
(2010). We also examine the relationship between the ownership pattern and the stock liquidity. We
found that higher promoter holdings reduce stock liquidity .We validate and strengthen the belief that
foreign institutional investors and their investments provide liquidity to emerging stock markets like
India. We support the arguments initiated by Gaspar and Massa (2007) that Ownership dispersion is
essential for improving the stock liquidity.

Limitations and scope for further Research

Measuring firm level governance was a challenging task in Indian context as corporate governance
ratings were not available. The findings of this paper can be generalized with a panel data analysis of
corporate governance index constructed from the year 2003for all the sample companies. All Indian
listed companies were required to follow Clause 49 of listing agreement on corporate Governance
since the year 2003. Similarly ownership pattern was examined with cross sectional data. Analysis of
time series data from 2003- 2010 for all the sample companies will strengthen the empirical
observations.
 References

Amihud Yakov, Illiquidity and stock returns: cross-section and time-series effects, Journal of Financial Markets 5
(2002) 31–56

Bacidore Jeffrey M. and Sofianos George,2002, Liquidity provision and specialist trading in NYSE-listed non-U.S.
stocks, Journal of Financial Economics ,63,pp.133–158

Becht Marco, 1999, European corporate governance: Trading of liquidity against control, European Economic
Review, 43, pp. 1071-1083

Bortolotti Bernardo, de Jong Frank, Nicodano Giovanna and Schindele Ibolya, 2007, Privatization and stock market
liquidity, Journal of Banking & Finance, 31,pp. 297-316

Brennan Michael J., Chordia Tarun and Subrahmanyam Avanidhar, 1998, Alternative factor specifications, security
characteristics, and the cross section of expected stock returns, Journal of Financial Economics, 49, pp. 345-373

Brown, Stephen, Hillegeist, Stephen, A., 2007, How disclosure affects the level of information asymmetry, Review
of Accounting Studies, 12,pp 443-477

Cai, Jie.,Quian, Yimg and Liu,Yixn.,2009 , Information Asymmetry and Corporate Governance, Drexel College of
Business Research Paper No. 2008-02. Available at SSRN: http://ssrn.com/abstract=1082589

Chan Justin S. P., Hong Dong and Subrahmanyam Marti G., 2005, A Tale of Two Prices: Liquidity and Asset
Prices in Multiple Markets, The Journal of Banking and Finance, Vol.32, No. 6, June 2008, Pages 947-960

Chen,Wei-Peng., Chung ,Huimin Lee., Chengfew and Liao,Wei-Li., 2007, Corporate Governance and Equity
Liquidity : Analysis of S&P Transparency and Disclosure rankings, Corporate Governance: An International
Review,vol.15,No.4,pp.644-660
Chung, Kee, H., John, Elder, and Kim, Jang-Chul., 2010, Corporate Governance and liquidity, Journal of financial
and Quantitative Analysis,Vol.45,No.2,pp.265-291

Cormier Dennis, Josee Ledoux Marie –, Magnan Michel, Aerts Walter, 2010, Corporate governance and
information asymmetry between managers and investors , Corporate Governance,Vol.10,No.5,pp.574-589

Datar, V., Naik N., and Radcliffe R., 1998, Liquidity and asset returns: An alternative test, Journal of Financial
Markets 1, 203-219

Ferreira, Miguel A., and Laux Paul A., 2007, Corporate Governance, Idiosyncratic Risk, and Information Flow ,
Journal of Finance , Vol.62,Vol.2, 951-990

Gaspar, J. M., Massa M.,2007, Local Ownership as private information: Evidence on the monitoring Liquidity
Trade-off, Journal of Financial economics,No.83,pp.751-792

Gompers P.,Ishij J., Metrick A., 2003,Corporate Governance and equity prices, Quarterly Journal of Economics,
118,No.1,pp.107-155

Grossman, Sanford , J., and Stiglitz, Joseph, E., 1980, On the impossibility of informationally efficient markets,
American Economic Review, Vol.70,No. 3, pp. 393–408

Jain, Pankaj K., Kim, Jang-Chul., Razaee, Zabihollah., 2008, The Sarbanes-Oxley Act of 2002 and Market
Liquidity, The Financial Review ,43, pp.361-382

Jiraporn P, Ning Y,2006 Dividend policy, shareholder rights, and corporate governance. Journal of Applied
Finance,Vol.16, pp.24–36

Kanagatetnam, Kiridaran,, Lobo, Gerald, J., Whalen, Dennis, J., 2007, Does Good Governance Reduce Information
Asymmetry around Quarterly Earnings Announcements?, Journal of accounting and public
policy,Vol.26,No.4,pp.497-522

Kyle Albert S., 1985, Continuous Auctions and Insider Trading, Econometrica, Vol. 53, No. 6 (Nov., 1985), pp.
1315-1335

Marcelo Jose´ Luis Miralles and Quiros´ Maria´ del Mar Miralles, 2006, The Quarterly Review of Economics and
Finance 46 (2006) pp. 254–267

Officer M (2006) Dividend policy, dividend initiations, and governance, Working paper, University of Southern
California, www.terry.uga.edu/finance/docs/officer.pdf

Rhee Gon S. and Wang Jianxin, 2009, Foreign institutional ownership and stock market liquidity: Evidence from
Indonesia, Journal of Banking & Finance 33 (2009) pp. 1312–1324

Ronald J. Gilson ,2000 ,Globalizing Corporate Governance: Convergence of Form or Function, 2000, Stanford Law
and Economics On line Working Paper No. 192; and Columbia Law and Economics Working Paper No. 174
Shen Chung Hua and Lin Kun-Li, 2010, The Impact of Corporate Governance on the Relationship Between
Fundamental Information Analysis and Stock Returns, Emerging Markets Finance & Trade / September–October
2010, Vol. 46, No. 5, pp. 90–105

Welker, M., 1995, Disclosure policy, Information Asymmetry and Liquidity in Equity Markets, Contemporary
Accounting Research, Vol.11, No.2, pp.801-827

Annexure I – Corporate Governance Score

Particulars Scoring Scheme

Number of Non executive Independent directors in total

(Percentage) 30-50% -1
50-65% -2
above 65%-3

Total number of board meetings 4 and Less than 4 - score 1

5-7 - score 2
8 and above - score 3

Independent Directors -Percentage Attendance in Board

Meetings 60% and Less - score 1
61-80% - score 2
81-90% -3
above 90% -4

Independent Directors -Percentage Attendance in Annual

General Meeting Less than50% - score 1
51-80% - score 2
81%and above - score 3

Chairman/Managing Director - same or different Same -1

Different-2

Number of audit committee meetings 4 and less than 4- score 1

5-6- score 2
Higher than 7 - score 3

Number of members in Audit committee 3 and less- score -1

 4-6-score 2
7 and above-3

Percentage of audit committee in audit committee

meetings Not given -0
Less than75% - score 1
76-90% - score 2
91% and above - score 3

Chairman of company Independent Non Executive -3

Independent Executive -2
Promoter Executive - 1

Retiring directors profile Not given-1

Given-2

Number of Share Holders General meetings Not given-1

Given-2

Compensation Committee Absent-1

Present-2

Number of compensation meetings Not given-1

Given-2

Annexure –II

Number of
Ownership Pattern among sample Companies companies
Central Govt. - Commercial Enterprises 9
Foreign Promoters 12
Tata Group 8
Birla Aditya Group 6
Reliance Group 5
Adani Group 2
HDFC Group 2
India Bulls Group 2
Om Prakash Jindal Group 2
Vedanta Group 2
Other promoter Groups Owning single company 40
Total Number of companies 90
Annexure III : BSE 100 Index companies : Industry composition

Sr.No. Industry Name No.of Companies

1 Aluminum & aluminum products 1
2 Auto finance services 1
3 Automobile ancillaries 1
4 Banking services 11
5 Beer & alcohol 1
6 Boilers & turbines 2
7 Cement 3
8 Commercial complexes 2
9 Commercial vehicles 2
10 Computer software 6
11 Copper & copper products 2
12 Cosmetics, toiletries, soaps & detergents 1
13 Crude oil & natural gas 2
14 Dairy products 1
15 Diversified 1
16 Drugs & pharmaceuticals 8
17 Electricity distribution 1
18 Electricity generation 6
19 Fertilisers 1
20 Generators, transformers & switchgears 3
21 Hotels & restaurants 1
22 Housing construction 2
23 Housing finance services 2
24 Industrial construction 1
25 Infrastructural construction 2
26 Infrastructure finance services 3
27 Investment services 2
28 LNG storage & distribution 1
29 Media-broadcasting 1
30 Minerals 2
31 Other asset financing services 1
32 Paints & varnishes 1
33 Passenger cars & multi utility vehicles 2
34 Pesticides 1
35 Refinery 5
Shipping transport infrastructure
36 services 1
37 Steel 5
38 Synthetic textiles 1
39 Tea 1
40 Telecommunication services 4
41 Tobacco products 1
42 Trading 2
43 Two & three wheelers 2
100